Real Estate Bets in Shaky Times

Most analysts are down on real estate investments, but investors can still benefit in some ways from exposure to the market

by David Bogoslaw

The slump in the U.S. housing market has convinced many investors to stay away from real estate investments for the foreseeable future, with analysts unable to call a market bottom. That's weighing not only on hard assets such as homes and condos, but on stocks like real estate investment trusts, whose prices have dropped since the beginning of the year.

Year-to-date through July 6, most of the REIT indexes have dropped by about 3%, to 6.5%, while the Standard & Poor's 1500 Composite index gained 8.5%, according to Standard & Poor's Equity Research (see BusinessWeek.com, 7/10/07, "A Rundown on REITs").

REIT investors look for attractive cash flows in the form of quarterly distribution income and capital appreciation over time. In terms of cash flow, publicly traded REITs—with yields of 3% to 4%—aren't attractive, compared with the higher yields on risk-free Treasury bonds, according to Milton Balbuena, chief investment strategist at Contango Capital Advisors, the wealth management arm of Zions Bancorporation.

With yields as weak as they are, investors are betting on the prospect of properties appreciating in value over time, which also is a bigger risk than it used to be, Balbuena says. In fact, with yields coming down, he's advising people to steer away from real estate altogether.

But real estate is still a key component of any investment portfolio for the diversification it provides and the low correlation to stock and bond markets, say other financial advisors. This week, Five for the Money looks at some ways that investors can still benefit from real estate exposure.

1. International REITs

Stay away from U.S. REITs, which account for roughly 55% of the global REIT market and are suffering from the housing slump, advises Jay Hutchins, president of Comprehensive Planning Associates in Lebanon, N.H. He steers clients toward mutual funds that focus on international REITs or on a mixture of international and domestic ones. He also prefers equity REITs, which invest in actual properties and make money on capital appreciation, to mortgage REITs, which offer income based on interest rates.

An easy way for people who don't have large portfolios to diversify is through the Morgan Stanley Global Real Estate Fund (MRLAX), which currently has 60% of its assets in foreign real estate. The distribution income is similar to a Standard & Poor's 500-stock index fund, and the expense ratio is reasonable—a little higher than 0.95%.

He also recommends the Alpine International Real Estate Fund (EGLRX), which has a strong track record and is up 15.5% year-to-date. It targets areas that are doing very well and is getting into emerging markets such as Brazil. Its expense ratio is 1.17%, which isn't cheap but may be warranted given its five-year rate of return of 31%, vs. 22.5% for the average REIT.

2. Private REITs

The primary advantage of REITs that aren't publicly traded is more stable cash flows and net asset valuations (NAV), as they aren't buffeted by stock market fluctuations. For one, their NAV is priced once every quarter, as opposed to public REITs that are priced daily and therefore are more volatile, says Michael Kuziw, vice-president for asset management at Lenox Advisors in New York.

Unfortunately, they're only available to retail investors through separately managed accounts, which are typically affordable only to people with cavernous pockets. To get what he thinks is a decent level of diversification in an SMA, the portfolio size should be at least $1 million.